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Bankers Versus Base

There may come a day, in January 2005, when the Democrats will come back to power. Can we perhaps divert ourselves from the campaign long enough to ask, what then?

The Democrats have a problem. Their base wants jobs and security. Their financial leadership wants a return to the Clinton formula of deficit reduction, leaving low interest rates to generate economic growth and jobs. John Kerry's emerging economic platform pays heavy homage to this formula, but it is unlikely to work out. A return to Bill Clinton's policies will not reproduce Bill Clinton's results. There are at least six reasons why this is so.

First, we are still in the turbulent wake of the technology slump. Capacity utilization remains low, depressing business investment. This overhang will heal eventually, but in most sectors it hasn't healed yet. As a result, private business is not yet poised for another takeoff; don't expect another dot-com bubble real soon.

Second, household debt burdens remain high. Households are therefore unlikely to fuel consumption growth by adding sharply to the debts they already have. More likely, the housing bubble will deflate, slowing rather than accelerating consumer spending in the years ahead.

Third, state and local governments are still cutting back, adding the drag of reduced direct-spending cuts and higher taxes to the economy. This is true even though overall state and local budget deficits have been reduced by drastic measures already taken.

Fourth, assuming growth does not give out on its own, interest rates are more likely to rise than to fall once the election is past. We are feeling the pressure now from Europe and Japan (and from our own "strong dollar" advocates) to defend the dollar against the euro. Alan Greenspan, in his oblique but unmistakable way, is already warning that this will happen.

Fifth, our growing structural trade deficit (including the effects of outsourcing) drains increasing U.S. demand overseas even as the economy tries to expand.

Sixth, a climate of fear and apprehension, much aggravated by Team Bush and its war on terrorism, seems to be weighing on the business mind. In such a climate, will companies boldly take new risks, requiring the addition of new employees to the payroll? It appears they won't do it very much -- though fits and starts will recur from month to month.

Back in 1992, the big barrier to growth was financial. Banks were recovering from the fiascoes of the 1980s and were unwilling to lend. Businesses and households, on the other hand, were very anxious to borrow. We had a "credit crunch," which Clinton's 1993 budget and Greenspan's monetary policies helped to unstick. After that, the economy grew largely on its own, powered by business optimism and household debt. Today, there is no credit crunch. Our problem is not a shortage of lenders but fear for the future. It is the classic symptom of a creeping depression.

These are the main reasons why job forecasts have been frustrated in the past three years. Economists purport to be surprised about them; we read in the press, repeatedly, that "no one" predicted it. That's not true. Economists who applied a systematic Keynesian framework to current conditions -- notably, Wynne Godley of Cambridge University and the Levy Institute, and this author -- have been issuing warnings on these issues since the 1990s.

And so, a strategy of fixing the deficits first-and-only won't work in 2005. Declining deficit forecasts will not ensure stable, low interest rates. And easy money will not suffice to bring us back to full-employment prosperity. More -- much more -- is going to be needed.

The same factors also work against the quick fix of another short-term "economic stimulus" program. One hears this old song from the liberal wing of the Clinton coalition, alongside calls for selective tax breaks of various kinds and increased job training. But under the conditions we now live in, short-term measures -- though useful -- work only in the short run. Once the stimulus ends, the effects do, too. Cases in point: We had a stimulus package in 2001 (rebates) and again in 2003 (child tax credits). After both, growth rates surged but then subsided. (This cycle may be happening again, thanks to large tax refunds being passed around right now.)

As for training, the problem is not a shortage of skills. It is an extreme shortage of good jobs, combined with bad pay and poor working conditions. Apart from some special cases, job training is a feel-good measure; it does not address the real problem.

The task of the new administration, therefore, will be to set a new direction for growth and jobs, not only for the short term but also over the medium and long term. Tax cuts (even if targeted well) and easy money are likely to contribute little to this objective. Health-care reform and education are important, but they probably create few new jobs. We need, in short, a patient strategy for social investment -- to meet pressing national objectives while creating jobs, recognizing that success will take determination, time, and money.

What objectives? The foremost candidate is sustainable energy security. Reducing our exposure to the world oil economy is a vast public challenge. It would move us toward compact cities, new transport systems, and renewable energy sources, as well as toward much more conservation and efficiency in the use of oil. That is the sort of national effort that would bring good jobs in quantity to the next generation, leaving our children and grandchildren better prepared to live well -- and in peace.

How to pay for it? Of course we must repeal George W. Bush's tax cuts on the wealthy. We should also forthrightly consider tax incentives to reward efficient energy use and to penalize waste. But for a project of national reconstruction and investment, much of the necessary funds can, and properly should be, borrowed. Policy should do what is necessary to restore jobs. Full employment, sustainable development, and national security are proper goals for policy. Deficit reduction, as such, is not. Public debt to enrich the wealthy is one thing. Debt to rebuild the country is something else again. If we have to go that route, we should do it and not look back.

Meanwhile, the right way to display fiscal discipline would be to separate capital from current expenditures in the budget, leaving the former free from any cap. Even over the long run, debt can grow as the country grows. Stabilizing the public deficit at, say, 3 percent of total income may be a reasonable midterm goal -- once employment, household finances, and our trade picture have been decently restored. But getting to that point will surely require more borrowing, not less, in the meantime.

The Democratic base and the financiers tend to clash on two other key issues: Social Security and trade. The financiers speak of a looming Social Security crisis. With this language, they signal a wish to "fix" the system by reducing benefits or by raising the payroll tax.

But is there a Social Security crisis? Actually, there is not. If the future economy performs even at the average of the past, or if population growth is more rapid (as the U.S. Census Bureau now assumes), the shortfalls disappear.

But suppose they don't. Even then, it's a crisis only if you think that Social Security benefits must always and only be paid from the payroll tax. But why should this be? Such taxes already take too much from the incomes of working households. Apart from raising the earnings cap, higher taxes on a declining base of employed workers would only make their hardships worse, as well as making it more costly for businesses to provide jobs.

So should retirement benefits be cut, directly as Alan Greenspan now advocates or by the subterfuge of privatization? No. Fully two-thirds of elderly Americans rely on Social Security for most of their income. They are not a pampered class and it is not their fault that they are living for a long time.

Here is an obvious solution: If there is a Social Security funding gap, fill it by raising taxes on those who can afford to pay. The right transfer is from the wealthy (some of them elderly), not from the young. How? Restore the estate and gift tax (and perhaps raise the rate on the largest estates). Impose a new top income-tax rate for millionaires. Impose new taxes on financial transactions. Close the loopholes that permit, in particular, the use of offshore tax havens. Revenues from these sources can be credited contingently to the Social Security Trust Fund -- to pay benefits if the pessimists are right and new revenues are eventually required. If not, they can go to deficit reduction.

New Social Security taxes may not be necessary. But if they are, both fairness and full-employment economics say that accumulated fortunes should be taxed before adding either to the difficulties of old age for the boomers or the tax burdens of low-wage workers.

Finally, the financiers maintain an unbroken commitment to free trade -- part of their enduring love affair with globalization. Here the financiers hold the high ground, because free trade is widely accepted as tantamount to virtue in economics. And outsourcing, though politically potent, is not the primary reason why we've lost more than 2 million jobs under Bush.

There are good reasons to favor open trade. But conditions have to be met for open trade to work. They aren't being met today, and we can change that.

First off, the all-purpose free-trade argument of comparative advantage just isn't very relevant to our trading world. Comparative advantage holds that increased trade raises productive efficiency in both trading partners. But this rests on differences in the technologies deployed by different countries. In modern trade in manufactured goods, technologies tend to be similar wherever found.

A cruder but more relevant argument for trade between North and South -- call it the Tom Friedman version -- rests on the simple fact that goods and services from poor countries are cheaper. This is not because technologies differ but because of lower wages paid for identical labor, under similar production conditions.

Some Americans do benefit when we purchase software from an Indian who makes $11,000 per year rather than from an American who gets paid five times as much. But does America benefit as a whole? The answer: It depends.

First, does the displaced American worker quickly find a new job at reasonable pay? If so, the loss (of income) is mainly personal. But if the jobs aren't there, the loss is also social -- the waste of talent and independence hurts us all.

Second, can we accept the redistributive effect? Part of what one American loses to trade or outsourcing (his or her job and the pay it generated) is usually gained by another American -- either the multinational who profits from selling at a lower cost or the consumer who gets a lower price. If the gain goes to profit, as it often does, growing trade raises inequality. If we don't like that, let's have rigorously progressive taxation (and, yes, redistribution) of those gains. This should be a price of trade -- and free traders should support it, much more than they do.

Third, the pro-trade, pro-outsourcing case assumes that there is no macro-financial risk. If exports always rose by the exact same amount as when imports rise, there wouldn't be any risk. But increased imports are actually paid for partly by adding to our permanent external debt. This is a short-term benefit. What used to cost, say, $55,000 per year in cash is now had for $11,000 on credit. But how long can it last? At some point, the price may truly be paid with a severe decline of the dollar and falling living standards in the next generation.

All of this suggests that the next administration ought to make a far more serious commitment, not only to full employment but to adjustment assistance, to progressive taxation, and to more equal wages and salaries -- spreading around, in the national interest, the gains from trade.

We should also consider the strategic as well as the equitable aspects of our trading patterns. Why continue to protect such bastions of Republican power and environmental degradation as Florida citrus and sugarcane? And is it really smart to abandon steel, which we will need for national reconstruction and energy security? Why can't a national investment program buy steel from American sources while leaving private steel users free to purchase cheap steel on the world market? If we used a National Interstate and Defense Highways Act to get ourselves into this pickle, why not a National Defense Rail Act to get out?

Perhaps most important, we are going to need a stabilizing reform of the international financial system in the years ahead -- a new system that will promote our advanced exports, and the global development process, and therefore help us to better balance our trade. It is not a change that financiers enjoy contemplating, as it will greatly erode their power. But the dollar-credit system is now more than 30 years old; it is unlikely to last another 30 years whatever we do. Our goal ought to be to manage a tolerable transition -- better for us, and better for the world, than the alternative of a crack-up. We should start thinking about how to do it, and fairly soon.

The next Democratic administration will be -- as always -- a coalition of monied and working interests. But whose interests should predominate? The Clinton formula put the liberal financiers in the driver's seat. Without question, that program worked: It had real costs, but the benefits, while they lasted, were greater.

The problem is that would be dangerous -- to national security, to the retirement security of working Americans, and to the very future of work in this country -- to assume that the same formula will work again. In all likelihood it won't.

And it shouldn't be tried, either. It will be better economics, next time, to align policy from the beginning, mainly -- though let us hope, carefully -- with the interest of working Americans who form the base of the Democratic Party.

About the Author

James K. Galbraith is the Lloyd M. Bentsen Jr. Chair in government-business relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin, a senior scholar of the Levy Economics Institute, and chair of the Board of Economists for Peace and Security. His most recent book is The End of Normal: The Great Crisis and the Future of Growth.